A budget plays a vital role in the smooth execution of planned actions, whether a business or household expenditure, as every dollar is essential and can efficiently add particular value.
Budget creation is more crucial for startup businesses due to the limited funds and comparatively low sales in the initial period. Startups aim to make a high impact with little money by adopting aggressive growth strategies, which usually reduce funds for unexpected events and lead to cash shortages. Thus, professionals recommend creating a budget with certain accuracy so that you can execute your strategies seamlessly and avoid cash shortages that can lead to business failure or closure.
In simple words, a startup budget is a classification of planning of utilizing available funds and managing expected business expenditures. In this guide, we'll take a look at why startup founders must prepare a budget before launching a business as well as how you can do it step-by-step.
The Need for a Startup Budget
A budget is a tool to investigate and analyze a business's capital requirement to cover costs and manage cash flows, especially in the initial months. It plays the role of roadmap without which the company can spend its valuable funds inefficiently or run out of cash in a short time. The budget can reflect a comparatively realistic picture of fund management created based on your best estimates and market research, such as what and how your competitor allocates the funding in the first few months.
Your budget plays a varying role at different stages of the business life cycle. Once the business starts settling, it becomes an analytical tool that you can utilize to evaluate spending on each area and income and their deviation from the planned ones. The planned versus actual analysis will highlight the business's internal issues, cost-saving opportunities, investment opportunities, and areas of improvement.
For instance, let's say you allocated a total of $60,000 for marketing. Then, you spent $50,000 on magazine single-page advertisements and $10,000 on online marketing. This marketing expenditure has driven around 70% of sales by online marketing and only 30% through advertising. Thus, it depicts that the business shouldn't spend more on magazine advertisements.
Why Is Budgeting Important?
Spending sufficient time and effort to develop a startup budget makes your business safe from unexpected financial hits and helps you make rational strategic decisions in the long run. Some of the most important reasons as to why entrepreneurs should invest in budgeting include:
- You can analyze and decide on the right time to hire new employees, invest in assets, or reinvest profits.
- You can set the limits for investment and borrowing, considering your cash-generating capacity.
- You can foresight your break-even point and manage the balance between fixed and variable expenses accordingly.
- You can project a realistic picture of your business considering current data and a few assumptions and share these with potential investors.
Keep in mind that you can make your tomorrow better by taking wise initiatives today. Thus, don't wait to push your plan to perfection before execution. It's better to start with an initial budget that you execute and improve later rather than going unplanned.
What are the Types of Startup Budgets?
Although budgets can be classified in several ways more broadly, there are two main types of budget:
- 1. One-Year Budget: This type of budget forecasts expenses monthly, weekly, or even daily. Developing a rolling budget and Profit and Loss (P&L) statement is an appropriate method. It is recommended to have shorter rolling intervals in the initial years, such as monthly or quarterly, and then plan for annual budgets once the business has grown.
- 2. Long Duration Budget: Usually, companies in the growth or maturity stage prefer to develop a longer-duration budget that provides a projection of long-term financial goals and spans 3 to 5 years. A startup business can prepare a more extended budget based on objectives and industry benchmarks. However, these might go through frequent adjustments in the initial years.
How to Create a Startup Budget?
There are some essential guidelines that can assist you in formulating the budget for the startup. Although you cannot perfectly predict each cent, you can reach a close-enough figure by following these steps.
Companies usually start budgeting based on competitors' analyses, market research, and vendor quotations. Remember, your budget is not a document to defend your business's profitability or sustainability. You need to be realistic, and it's better to underestimate earnings and overestimate expenditures to prepare for the worst-case scenario.
Let's take a look at the steps you should follow to develop a startup budget.
Step 1: Gather Tools and Set Target Budget – A Benchmark
First, you need to start using a tool such as a notebook, an Excel spreadsheet, budgeting software, an integrated financial tool, or a dashboard. Selecting the appropriate tool depends on your business need, the individual's capability who will own and manage that budget, the size of the business, and complications.
Then, deciding on a budget target is crucial to monitor performance and deviations. It is recommended to keep emergency funds or buffer money for unexpected worst scenarios up to 3 times the business's total expenditures.
Step 2: List Essential Startup Costs
The startup cost is the spending amount required in year zero to launch a business. It is also known as an initial investment. It includes the purchase of assets and expenses incurred to run operations and costs. There are essential resources required to execute the core business activities, i.e., delivering products or services and generate revenue.
- 1. Startup Assets: These are usually one-time purchases of fixed assets such as property, machinery, furniture, and vehicles, and current assets such as inventory assets. These are non-tax-deductible capital expenditures.
- 2. Startup Expenses: These consist of both fixed and variable expenses that need to be paid before launching a business.
Step 3: Determine Fixed Costs
Fixed costs, also known as overhead costs, include expenses that remain the same each month and need to be paid regardless of production or sales units. Fixed business costs include items like:
- Rent or mortgage
- Payroll and other benefits
- Website maintenance
- Bank fees
Make sure to select your fixed costs wisely. For example, having an in-house IT team might become more expensive than outsourcing because it might require additional items like equipment, an office, furniture, and salaries. Therefore, it is crucial to analyze your business needs and do a cost-benefit analysis. Otherwise, you might end up with the burden of fixed costs and run out of cash very early.
Step 4: Estimate Variable Costs
Variable costs are expenses that vary with increases and decreases in sales and production. Therefore, these don't remain constant for each month. These costs generally increase with the expansion of business and growth in sale units. Some significant variable costs are:
- Raw material
- Shipping costs
- Travel and events
- Advertising expense
You can use sector averages or request quotations from contractors, manufacturers, and third-party logistics providers (3PLs) for most of these expenses. Some variable costs are subject to change periodically (e.g., yearly, quarterly, etc.).
Step 5: Incorporate Interest and Tax Expenses
The interest payment depends on your borrowing and the country's economic environment, whereas taxes depend on profit before tax and the country's policy. It is better to plan tax expenses based on the state policy in which the business operates.
Step 6: Calculate Monthly Revenues
Forecasting earnings is an essential budget component, but how can a startup predict revenue with no past trend or historical data? One way to estimate future income is to analyze your target market, the number of units a single customer is expected to buy, frequency of purchase, and customer lifetime value to drive projected revenues.
Another way is by benchmarking the figures with competitors or evaluating their revenue growth in the initial years. It's best to develop both optimistic and pessimistic scenarios of revenue forecasting.
Step 7: Review and Adjust Total Costs
Now enter the value of each component in your budgeting tool or template and calculate how much money you have to start your business and how you will manage cash. Don't forget to keep emergency or buffer funds to face the worst scenarios.
Working on individual components and then reviewing a collective picture in the budgeting model might reflect some necessary adjustments to make your budget more realistic and relevant. Keep in mind that it is okay to make adjustments. Revisit each expense as either an essential expense or a discretionary one that is nice to have and analyze which costs can be minimized or eliminated to maximize earning and savings.
A startup budget is a perfect defense to protect your business against unexpected financial issues. It enhances the business flexibility and adaptability to respond to changes and timely amendments without significantly impacting cash management.
To attain fruitful insights from the budget, one must also select and use the right tools that can significantly assist in the process, such as Excel templates and budgeting tools.